Profit fade has been plaguing the construction industry for years. Companies start the year with high expectations, but as individual jobs go overbudget, they cut deeper and deeper into profits. The only way to stop profit fade and hold onto the profits earned throughout the year is to gain situational awareness.
Situational awareness is essentially an understanding of the company’s financial performance, including how all jobs are progressing and how they are expected to close out. It requires taking a forward-looking approach to company and job-specific financials as well as an adherence to financial metric and reporting best practices. But finance teams at middle market construction companies are often small and lack the resources and know-how needed to implement these best practices.
To gain situational awareness and grow earnings quarter after quarter, companies need to change the way finance interacts with the rest of the organization. By elevating their role and providing more transparency around job performance, they can track budgets more closely, spot trends, and take a forward-looking approach to financials. And here is how to do that.
One of the best ways to take a forward-looking approach to finances is to change the way finance interacts with the management team. Very often, finance teams act more like a controller than forward-looking financial analysts. As they close the books on a job, they look back at what happened, and the leadership team looks back in frustration at the controllable factors that resulted in lower profits than expected (or losses). But because they were not aware of the issues while there was time to take corrective action and the project has ended, there is nothing the company can do to recoup its losses.
Modern finance teams need a leader who is part of the leadership team and identifies trends and delivers performance insights in order to avoid negative situations and maximize positive outcomes. The team needs total transparency as to how jobs are performing on a current basis, so they can address issues and marshal company resources to keep projects on budget.
It is absolutely essential that middle market construction companies set a yearly budget broken down by month. More importantly, companies need to actually evaluate performance against that budget every month. Without this vital step, the budget becomes useless after day one.
Monthly reviews require the most up-to-date financial reports, which means closing the previous month’s financials within 10 to 12 days of the month-end. If you wait any longer, the usefulness of the information decreases significantly in that the ability to collaborate with the management team to take active and corrective measures to maximize financial performance is diminished or lost. At the end of each quarter, teams should also reevaluate the appropriateness of their budget and make adjustments as necessary.
When it comes to reporting and metrics on the jobs side, the finance teams should meet with project managers to review job performance at least weekly. If a job is set up well, the team should know the costs they will incur each week from both a labor and materials standpoint. Those costs should be reviewed each week to ensure the project performance is on track to meet or exceed the budget.
Many companies struggle to control labor costs effectively, but with weekly reviews, project managers can track those costs more carefully and make adjustments if needed. For instance, if additional hours (and labor costs) are needed because the project manager did not fully understand a job requirement or the drawings were not indicative of what they encountered on the jobsite, the team can pause and determine a way to fix the issue without exceeding the labor budget.
A forward-looking financial strategy and regular reviews are effective because they allow the finance team to course-correct before a job’s costs get out of hand. If a design issue comes up, the project manager can adjust the labor schedule and give the crew a two-week break until the issue is resolved. If the scope of a job changes or if the job conditions require more materials than what was originally agreed upon, you can pause and have a discussion with the client regarding how to recover the additional costs.
It is much better to have those discussions early when there is a higher likelihood of recovering additional costs through a change order than after a project is complete, when the client has little motivation to cover unexpected costs.
Once a finance team gets in the habit of setting annual, monthly, and job-specific budgets—and reviewing them regularly—the team will learn to spot negative trends and determine what is causing them. Regular conversations between project managers and the finance and leadership teams allow the company to stay on path and identify problems early enough to react and adjust. And if the same problems are occurring on job after job, it is a good sign that larger issues exist and need to be addressed.
Implementing these best practices to gain situational awareness often requires the assistance of outside help. FortéOne consultants have more than 20 years’ experience building and leading construction companies and modernizing financial operations. They can teach your finance teams the skills required to adopt a forward-looking approach to company and job financials, so you can eliminate profit fade for good.